Description

Has anyone on VIC ever heard of the Illinois Basin?  Over the years, there have been some terrific write-ups of the larger public ILB players (Alliance, Foresight, Hallador) with outstanding accompanying Q&A.   Paringa Resources is a very small dual-listed (ASX primary ticker PNL) company that has spent several years bringing a small ILB mine into production.  Along the way it has underestimated costs, missed deadlines and done what it could to shred its credibility with the few investors that followed it.  A new CEO with a background as a senior NY industrials investment banker took the helm in Dec 2018 and he will not be settling for mediocrity.  Down over 55% in the last year and 84% since early 2017 when it detailed its feasibility study, the stock did not re-rate when production began earlier this year (first coal delivered at end of April).  No one seems to care. With all the risks that come with a ASX-listed but US-based, levered single-mine thermal coal asset with an intermediate cost position that will not generate cash until next year, we still believe that Paringa could triple as production ramps up to 2023 and cash is generated (based on a turn discount to large multi-mine companies) with longer term upside from a second adjacent mine.     (Note that in the table above I have priced the ASX stock in AUD even though there is a US listing that is completely illiquid.  Everything else above and below is also in USD unless otherwise noted.) Also did my best on the formatting - hopefully it is sufficent.  

Business Description (see also 20-F and investor presentation online at website)

In March 2019 Paringa began production from its Poplar Grove mine and delivered first coal to customers in April. Per management, the mine will exit the year at a 2.2 million ton run-rate at which point in time it will be generating cash.    After some additional growth capex in 2020, the mine will be capable of producing 2.7/2.8 million tons in 2021 with a long mine life.  This production would represent approximately 2% to 2.5% of the total production in the ILB (as of 2018).  For reference, here is a table of recent ILB tons from 54 mines:

To fund this production Paringa initially had a five year $21.7 million debt facility with Macquarie but the new CEO realized it was not enough capital and refinanced it in April with Tribeca Global Resources.  The current debt is a two-tranched facility ($40m now which is $21.6m net cash after taking out the previous facility and an additional $16 million after milestones, likely next year) at prime + 7.5% (approx. 13%).  There is also an up to $19 million equipment facility that can be expanded by $7.5 million with Komatsu that had a $5.6m balance at 12/31/18 – rate not disclosed but I assume 7.5%. 

Paringa’s mine is in Western Kentucky and some of it is actually on the same seam (WKY-9) as some of Alliance’s production (the rest is WK-11).  Paringa is a room & pillar continuous miner like Alliance.  That said, its cost position is higher than Alliance which is an outstanding operator (see those write-ups).  Paringa cites a Wood Mackenzie report that its production cost is near the middle of the ILB range.  It adds however that its location on the Green River allows it to inexpensively deliver to the Ohio River (FOB Ohio River) at a $10 cost advantage to other mines not on the Green River.  This brings its relative costs to the same range as most of the lower cost operations for a certain set of power plant customers.  The company has confirmed that nearby Alliance properties do not share this logistical advantage.  Overall this type of coal is priced as “Western Kentucky Underground” and page 7 of its investor presentation shows a range of below $35 in 2008 to nearly $50 in 2015 before drifting to just below $40 today.  Note that Paringa’s cash costs including SG&A and maintenance capex are projected to be around $33.50.

Per the Company’s July 19^th 6-K, 100% of 2019 is contracted and 75% of 2020.  It also says 50% of next 5 years is contracted which implies that 2021 and on are approximately 43% contracted.  In that document, the company announced that a smaller customer canceled its contract with them due to delays in delivering it coal but it sounds like the door is open to re-sign them later this year.  

Below is the company’s projection for 2020 onwards.  I have made several assumptions for the management case to build out a cash flow model:

·         I have ignored the tax shield of non-cash DD&A.

·         Because Alliance’s change in NWC moves around in a way that is not correlated with sales, I have assumed zero here.

·         Since there is no guidance on 2019, I have assumed that Paringa there is no cash on its balance sheet at year-end to reach cash flow breakeven.  This is punitive but since Paringa has not filed its credit agreement so we cannot see what the minimum cash balance covenant is, this will suffice. This cushion will be partially offset by any increase in the equipment facility so directionally this is correct. 

·         Negative cash at YE 2022 is the amount of debt to be refinanced – 2023 interest expense is at the same rate.    

Note that growth capex in 2023 is for an airshaft and could arguably be defined as maintenance. 

Longer term, there is an adjacent property called Cypress that was originally going to be the first property developed and thus it is fully permitted.  The company estimates an approximately $102 million construction cost.  This could come on in 2024 or later depending on if debt or internal cash flow is used to finance it.  

Here is an overview of the current capitalization of the company:

In the above I have included the milestone-based share payments but excluded out of the money options that have the following strike prices:

Per share calculations below use the “FD Share Outstanding” above but I have included options via treasury method in the share counts used for the potential upside calculations where share prices are higher.  The 2.3m options were granted in the six months ended 12/31/18 but no strike price was disclosed so I used the lowest price in the period to be conservative.    

Valuation

Here is how the market is valuing ILB companies:

A low-cost multi-mine pure ILB producer is trading north of 4x trailing EBITDA.  Looking at 2021 and 2023 and assuming a 1 turn-discount for being a smaller single-mine producer, would suggest 70% to 250% returns.  By adding the Cypress mine in 2024 (EBITDA proportional to production despite likely SG&A absorption across larger base) and the debt to construct it and using a 3.5x multiple there is more upside.     

Note that this methodology (applying a 3.0x multiple) to 2020 while the company is taking on additional leverage for growth and production is not fully ramped would imply that the stock is overvalued already but I do not think that is a realistic way to approach the valuation. 

Downside:

To stress test, beginning in 2021 I price all non-contracted coal at the 2008 WKY price of approx. $34.00.  In this scenario EBITDA would be closer to $14 million in 2021 and $18 million in 2023.  Assuming that Paringa could refinance, its net debt to that lower EBITDA in 2022 would be 3.3x which is not a Foresight multiple but depending on the overall valuation of the enterprise, there may not be much value ascribed to the equity.   If production never grew beyond 2020 despite growth capex then with the 08 pricing case the Net Debt / EBITDA in 2021 would be more like 5.2x (case not shown below).  In a normal business valued as a going concern that would be on the higher side but given the multiples of coal companies, then Paringa might have the opportunity to join the prestigious restructuring ranks of its larger brethren.   Cut price realizations, cut production and increase costs and that would be a certainty (case not shown below).

Here is the $34 08 pricing case beginning in 2021 assuming costs and production are in-line with management’s current projection:

Investment Positives

·         Only a small producer so incremental production relative to the ILB so unlikely to move the needle on its own.

·         Coal / ILB out of favor with everybody: other public companies currently remaining cautious about bringing on additional production.

·         Insulated somewhat by $10 pricing advantage due to barge-ability on Green River to power plant customers who pay FOB Ohio River.

·         Key contract with Louisville Gas & Electric (PPL) contracted and priced out longer than industry practice of 1-2 years.

·         More contracts likely coming soon that will decrease uncertainty around pricing. 

·         Would have been EBITDA positive during recent coal-mageddon of 2015-17 and at any time since 2008.

·         Customers want a new source in a consolidating basin. 21 power plants receive 20 million tons via barge.

·         ILB is the “cleanest dirty shirt” as it has no railroad issues like PRB or higher cost issues like NAPP/CAPP

·         Longer term optionality on adjacent property Cypress.

·         Export market for ILB coal exists which could mitigate domestic demand decreases as larger producers export.

·         No legacy liabilities.

·         Would be an easy tuck-in for nearby Alliance.

·         New CEO with finance background will ensure capital spending has a good return (barring geological issues outside his control if they exist).    

·         $84 million of PP&E as of 12/31/18 relative to $53 million enterprise value.

Investment Concerns

·         It’s a miner.

·         Secular decline of domestic coal demand will keep valuations low.

·         Foresight could bring on an additional amount of sub-$20 coal in the ILB.

·         Not lowest cost (but location enables it to deliver competitively to its Ohio River customers).

·         Single mine risk.

·         Not cash flow positive yet.

·         Levered and will have to refinance (less than a turn of EBITDA in base case, more if performance is worse) at time of bullet amortization in 2022.

·         Credit agreement not public so we don’t know what the covenants are. 

·         50% of out-years production uncommitted.

·         A carbon tax seems unlikely today but would dramatically reduce profitability.  

·         No met coal exposure.

·         Every VIC member knows that natural gas can always go lower and utility customers can eventually switch feedstock.

·         Stock is illiquid.  Trades USD $500k/day.

·         It’s a miner (in case you missed it at the top)

            Disclosure 

We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the contents of this document and expressly disclaim liability for errors and omissions in the document.  We have no obligation to update this document.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Readers should do their own research.

Catalyst

Cash Flow Generation / Evidence Cost Projections are Accurate, More Long Term Sales Contracts